31 Oct 2023
Having returned from a recent trip to San Francisco, Portfolio Manager Greg Kuhl discusses why the team is cautious on the local office market.
The JH Explorer series follows our investment teams across the globe and shares their on-the-ground research at a country and company level.
An American Housing Survey conducted by the US Census Bureau – highlighted in early October by the San Francisco Chronicle – shows that 8% of the city’s population plans to move away in the next year; the highest percentage for any US city (for comparison, Chicago and New York come in at 5% and 3% respectively).1 Employers are leaving too; office space availability in San Francisco has increased from 10% in 2020 to 37.5% today. This is an unprecedented move even for a market with a well-established ‘boom bust’ history.2 The city is frequently the subject of news articles with headlines like “Can San Francisco Save Itself from the Doom Loop?”, highlighting the quality-of-life challenges associated with homelessness, drug use, mental illness, street crime, and the high cost of living in the area.3
Not all real estate is equal
I recently spent several days in and around San Francisco to gain perspective on this somewhat controversial property market. Commercial real estate consists of various property types, all with unique and sometimes uncorrelated supply and demand fundamentals – San Francisco exemplifies this. For many of the property types we visited, including apartments, industrial, and suburban retail, we would concisely characterise local fundamentals as varying between ‘fine’ and ‘good’. Data centre fundamentals seem even stronger, bordering on ‘great’. Like most of the rest of the US however, office is the outlier to the downside in San Francisco and the greater Bay Area.
Potential opportunities in listed office space when fundamentals improve
Listed office real estate investment trusts (REITs) with heavy exposure to San Francisco including Kilroy Realty (KRC), Hudson Pacific Properties (HPP), and Paramount Group (PGRE) are down between 60-82% from their pre-COVID stock prices, and have materially underperformed listed office peers and the wider listed REITs sector.4
When sentiment is this bad and prices have declined this much, we need to ask ourselves: “Could there be an opportunity here?” After much consideration, our team remains cautious on this small corner of the listed REIT market for a few primary reasons:
As always, on the ground diligence is an important part of our team’s investment process. We are well aware of the tech-related boom potential that exists in San Francisco, however, we will only attempt to take advantage of any discounted valuations once it is clearer that fundamentals are improving.
1 SFGATE: More People Want To Leave San Francisco Than Any Other City, Survey Shows; 15 October,2023.
2 CBRE San Francisco/Silicon Valley Office Market Outlook.
3 Wall Street Journal, August 13, 2023.
4 Bloomberg, 14 February 2020 to 13 October 2023, total returns in US dollar terms. References made to individual securities do not constitute a recommendation to buy, sell or hold any security, investment strategy or market sector, and should not be assumed to be profitable. Janus Henderson Investors, its affiliated advisor, or its employees, may have a position in the securities mentioned.
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